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The Merger Guidelines and its 1982 and 1984 predecessors represent a
major advance over the state of the law and enforcement practice prior to 1982. I
know this because I was a brand new lawyer in the Antitrust Division in 1979,
and I well remember my sense of befuddlement at being presented with my first
merger matter. A disciplined framework for thinking about market definition, in
particular, would have been most welcome. The Guidelines provided that
framework.

In the face of that signal contribution, the comments here might seem like
mere caviling. In the spirit of continuous improvement, however, I offer a few
modest suggestions, grouped under two headings:

More explicit recognition of the role of uncertainty, and

More explicit recognition that the assessment of competitive effect is the
underlying purpose of market definition.

More Explicit Recognition Of The Role Of Uncertainty

The Hypothetical Monopolist Test Tempts Staff to Reverse the
Proper Burden of Proof

It is a truism that the government bears the burden of proof in a merger
case. The very nature of the hypothetical monopolist test, however, tempts staff
into reversing that burden. This is so even though the Guidelines explicitly state
that they do not attempt to assign the burden of proof or the burden of coming
forward with evidence.

The agencies "begin with each product . . . and ask what would happen if
a hypothetical monopolist . . . imposed at least a 'small but significant and
nontransitory' increase in price" [SSNIP]. "If, in response to the price increase,
the reduction in sales of the product would be large enough that a hypothetical
monopolist would not find it profitable to impose such an increase in price, then
the Agency will add to the product group the product that is the next-best
substitute for the merging firm's product." It is a natural human tendency to
place the burden of proof on those who argue that something would happen, not
on those who say it would not happen. Put another way, the hypothesized price
increase is treated as fact, and the hypothesized diversion to other products is
treated as speculation. The result will be a bias in favor of narrower markets--a
boon to the merging parties if their products are not in the same market as a
result, but an impediment to them otherwise.

I am not suggesting that this is a huge or frequent problem. Oftentimes,
the market definition issue is not a close one, or the issue turns on issues such as
whose econometric model is more convincing. Often, too, neither side explicitly
defines a market, at least not in discussions with each other. The staff's Merger
Screening memo may contain somewhat off-the-cuff market definitions, and
associated HHIs, but nothing of substance turns on them. Nonetheless, the bias
is there, subtle as it is, and in rare cases, it may actually make a difference.

At the risk of being branded an antediluvian, let me suggest a possible
role for the Brown Shoe "practical indicia" here. If, as a practical matter, business
people in the ordinary course of business treat the market as being broader,
someone applying the Guidelines test should stop and think twice, or maybe
three times, before concluding that the market really is significantly narrower.

"Too Many Notes"

A second uncertainty-related issue springs not from the hypothetical
monopolist test itself, but from the fact that product and geographic market
determinations are only two of many steps that an analyst theoretically takes to
make a judgment on the ultimate question of overall competitive effect. Without
in any way denigrating the masterful symphony that is the Guidelines, and with
apologies to the playwright Peter Schaffer, I am reminded of the scene in the
movie Amadeus in which Emperor Joseph II comments that Mozart's opera has
"too many notes." Perhaps the Guidelines contain "too many steps." If merger
analysis consists of a long series of steps, all of which must be answered in a
particular way for the merger to be anticompetitive, and all of which are
inherently uncertain, it is easy to reach the wrong result if one treats each step as
fully answered and concluded before moving on the next.

A simple example will illustrate the point. Suppose that in the proposed
merger of A and B, C is a firm (perhaps in an adjacent market) that might be able
to enter quickly and without sunk costs, and D is a firm that might be able to
enter within two years after incurring substantial sunk costs. Suppose there is a
51% probability that, absent the merger, if A were to raise the price of its
product, customers would turn to B in sufficient quantities to defeat the price
increase. Suppose further that there is a 49% probability that C is in fact an
uncommitted entrant that could defeat the price increase, and suppose further
that there is a 49% probability that the entry of D would be timely, likely, and
sufficient to defeat a price increase. The probability of an anticompetitive effect
from the merger is 51% x 51% x 51%, or about 13%. An inexperienced analyst,
however, could easily reason as follows: "It is more likely than not that A and B
collectively constitute a market. It does not appear likely that C is an
uncommitted entrant. Nor does it appear likely that entry by D would prevent
an anticompetitive effect. Therefore, we should challenge the merger." Given
that the staff and the parties have asymmetric access to the witnesses and
documents of customers and other third parties, and given the staff's proper
reticence in disclosing information obtained from third parties, it can be
extremely difficult to know when the staff has inadvertently fallen into this
logical trap.

"Customers Say They Wouldn't Switch"

The information asymmetry issue comes into play in a context other than
the layered uncertainties of a multi-step analysis. This was truer in the early
days of the Merger Guidelines, when it was more common for the staff to ask
customers the "hypothetical price increase" question outright. Today, the focus
seems to be more on either concrete past behavior or on objective circumstances
such as the timing and costs of switching products. In consumer products,
where scanner data are available, the hypothetical question neither needs to be
nor can easily be asked directly in any event. Ultimate consumers are simply too
numerous; if one were to try to ask the question directly, one would engage
survey experts who would, one hopes, explain the limitations and pitfalls of such
research and try to protect against the most obvious errors. With intermediate
goods, however, staff often begins by doing telephonic interviews of the
principal customers. Here, the danger of badly worded questions eliciting
misleading information about the unknowable is at its greatest. At the same
time, the difficulty of staff and parties joining issue on the implications of
conversations to which the parties cannot be privy is also at its greatest. To the
extent that staff says, "customers say they wouldn't switch," the likelihood of a
productive dialogue is quite small. The discussions are off to a much more
productive start if the conversation begins, "customers say they wouldn't switch
for the following four objective reasons."

More Explicit Recognition That The Assessment Of
Competitive Effect Is The Underlying Purpose Of Market
Definition.

When Should the Analysis Depart from 5%?

The Guidelines state that "what constitutes a 'small but significant and
nontransitory' increase in price will depend on the nature of the industry, and
the Agency at times may use a price increase that is larger or smaller than five
percent." I suggest that--on the principle that the assessment of competitive
effect is the underlying purpose of market definition--there is a rational basis for
departing upwards from 5% in particular cases. I also suggest that, although
there is a principled basis for departing downwards from 5% in particular cases,
one should never do so, and that one should accordingly delete the sentence in
Section 1.0 that states: "The 'small but significant and non-transitory' increase in
price is employed solely as a methodological tool for the analysis of mergers: it is
not a tolerance level for price increases."

Let us takes the upward departure first. Imagine a situation in which a
price increase of 5% would lead to the loss of x units of sales. Suppose that the
profit on those x units is greater than the increased profits on the sales that the
seller would continue to make. Therefore, a 5% price increase would not be
profitable. Now suppose that the next tranche of customers is highly
price-inelastic. Even with a price increase of 10%, the seller still loses no more
than x units of sales. But this time, with a 10% instead of a 5% price increase, the
increased margin on the sales that are kept is great enough to outweigh the lost
profits from the sales that are lost. Now the price increase is profitable. Because
the purpose of the market definition exercise is to protect consumers from being
harmed, why would we not want to guard against this 10% price increase?

The same argument could be applied, of course, to price increases smaller
than 5%. A price increase of 1% might cause a small enough loss of unit sales to
be profitable, whereas a 5% price increase would not. If we knew exactly what
would happen with perfect foresight--if the world resulting from the merger
and the but-for world could be known without any uncertainty--I would be
perfectly comfortable defining the market based on such a 1% price increase. I
suggest, however, that, on average, the uncertainties of life swamp any effort to
make such fine distinctions. In order to have some reasonable benchmarks--not
only for planning and counseling, but also to avoid unnecessary interference in
procompetitive mergers--I propose that we accept 5% as a tolerance level.

It Is Time to Reconcile Unilateral Effects With Market Definition.

There are some confusing redundancies between market definition and
competitive effect in the Guidelines. For the most part, they do no harm.
Nonetheless, there are confusing. If one is going to revisit the Guidelines
anyway, one might want to consider eliminating such redundancies. Probably
the leading example is trying to make sense of unilateral effects in light of the
sentence in Section 1.11 that reads: "In performing successive iterations of the
price increase test, the hypothetical monopolist will be assumed to pursue
maximum profits in deciding whether to raise the prices of any or all of the
additional products under its control." This appears to mean that the
sustainability of 5% price increase in only a single one of the hypothetical
monopolist's products is sufficient to define a market. If that is so, then market
definition vitiates the need for a unilateral competitive effects analysis.
Unilateral effects analysis says that a merger is anticompetitive if, as a result of a
merger of A and B, the post-merger entity can raise the price of at least one
product without accommodating reactions by other competitors. This may
occur, for example, because the market is differentiated and A and B are each
other's closest competitors. But if the sustainability of a 5% price increase in only
a single one of A's and B's products is sufficient to define a market--as the
above-quoted sentence from Section 1.11 seems to say--then by definition, a
unilateral effect consisting of a price increase of 5% or more is also a merger to
monopoly.

Three possibilities come to mind for reconciling market definition and
competitive effects in this context:

The two sections are simply redundant.

The market definition section allows the agencies to evade the 35%
benchmark in the competitive effects section.(1)

The competitive effects section allows the agencies to attack a price
increase of less than 5%, assuming the agencies do not want to achieve the
same goal by varying the 5% benchmark for market definition.

Whatever the explanation is, some clarification appears desirable.

Bring Supply Substitution Back Into Market Definition.

I hesitate to talk about a case that I know only from the outside. Both the
staff and the lawyers for the parties saw many documents that I will never see
and talked to witnesses to whom I will never talk. So take this discussion for
what it is: a "methodological tool" for talking about the Guidelines, not a
comment upon the outcome in a particular case. With that caveat, can "intense
mints" really be a market? Would not makers of regular mints easily be able to
carry out line extensions into the "intense mints" space? Or was this a case in
which, once the market was defined, it was all too easy to skip over steps such as
uncommitted entry, product repositioning, or committed entry?

I don't know, and the answer may be as simple as the fact that when the
staff has the leverage to extract a consent order, all doubts about the effect of the
merger tend to be resolved against the parties. But I do sometimes wonder
whether the need to obtain a current market share to plug into the spreadsheet in
order to generate an HHI number leads staff to systematically underweight the
competitive influence of firms whose current market share is zero.

Conclusion

As I said at the outset, my comments on the market definition sections of
the Merger Guidelines are minor ones. The Guidelines represented a significant
advance, and their achievement has withstood the test of more than two decades.
If the agencies are inclined to do some fine-tuning, however, I hope these modest
suggestions prove useful.

FOOTNOTES

* Partner, Morgan, Lewis & Bockius LLP. These comments reflect only the views of the author and not
necessarily those of Morgan Lewis or any of its clients.

1. Dropping the 35% benchmark would probably be a good idea in any event; I have yet to understand how it is helpful to a unilateral effects analysis.